OCEAN CITY — Analysts need to be particularly selective about the indicators they rely on. Rather than trying to digest each and every piece of daily market data available to them, they de-emphasize the numbers they consider less important and increase the attention they pay to select statistics — the ones they trust to give them a clearer, more accurate picture of the economic outlook. It’s an approach that can serve individual investors as well.
Joseph Zidle, head of Global Wealth Management Investment Strategy at BofA Merrill Lynch Global Research, divides most market data into three broad categories: leading indicators, coincidental indicators and lagging indicators. Leading indicators give Zidle an idea of where the global economy is heading. Coincidental indicators tell him what’s happening right now. And lagging indicators help explain to Zidle what happened last month or even last year.
“For investment strategists, leading indicators are by far the most important,” he says. “Whether the economy is up or down, there are always opportunities for investors who are paying attention to what those indicators are saying.”
So what leading indicators does Zidle pay most attention to? Here are his top six
The S&P 500
At first blush, Standard & Poor’s iconic index of stock prices for 500 of the largest U.S. companies might seem more focused on the present than the future. But Zidle notes that the direction of the S&P 500 index can be an important indicator of overall equity performance for the coming 12 to 18 months. And this is not only for U.S. stocks; the index has a surprisingly broad global perspective: Although its component companies are in the U.S., Zidle points out, 36% of the revenue of S&P 500 companies and 40% of their profits are generated outside the country.
Average Weekly Hours
Factory operators with new orders are not likely to hire until they’re convinced the new business has staying power. Instead, they’ll bump up the hours of their existing workers. The same is true in reverse: Instead of laying off workers, employers might cut back hours during slow times to see whether the doldrums are more permanent. For these reasons, average weekly hours data — part of the monthly Employment Situation Summary published by the U.S. Bureau of Labor Statistics (BLS) — are considered a better early indicator of the economy’s direction than job numbers.
Temporary Staffing Levels
For many employers, adding temporary workers is a middle step between increasing existing employee hours and hiring new permanent workers. The BLS monthly report contains a line item on temporary-help services, but Zidle says a fuller picture of the temporary-staffing situation requires more digging. Statements made by executives at temporary-staffing companies concerning their business prospects are one source he monitors closely.
The U.S. Census Bureau’s New Residential Construction report tracks building permits and housing starts and completions. Historically, construction is one of the first sectors to pick up during an expansion, making the report an important sign of economic activity. But among the three components, Zidle looks most closely at building permits, which provide an advance signal of future growth in construction jobs, demand for building materials and lending activity.
Interest Rate Spread
Also known as the yield curve, this statistic compares the yields of bonds of various maturities, typically short-, medium- and long-term U.S. Treasury debt. A normal yield curve slopes gently upward, with short-term T-bills paying lower interest than longer-term notes and bonds. An inverted curve — in which short-term rates are higher than long-term — signals that the economy could be headed into recession, as pessimistic investors compete to lock in long-term interest rates, thereby driving down yields. A steep yield curve, on the other hand, typically occurs at the start of a period of strong economic growth.
ISM Manufacturing Index
The Institute for Supply Management gathers data from more than 300 purchasing and supply executives at U.S. companies for its monthly report on manufacturing activity. The index, which tracks changes in areas such as production, new orders, employment, inventories and prices, is based on hard numbers, not projections, and it’s an early sign of how the economy is trending. A number greater than 50 indicates economic growth, while one less than 50 signals a slowdown.
The data reported in January 2011 were generally positive, with the S&P 500, average weekly hours, building permits, temporary staffing levels and the ISM manufacturing index all trending higher. The yield curve, meanwhile, was steeply sloped, suggesting that bond investors were anticipating economic growth.
“With all of these indicators,” Zidle says, “it’s the trend that’s important, not the number itself. Investors should consider using them as guides for adjusting the asset allocation in their portfolios in response to the direction of the economy, not as on-off signs for getting into or out of one asset class or another.”
(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)